Real Estate 2021

Last Updated April 13, 2021

Japan

Law and Practice

Authors



Mori Hamada & Matsumoto has 13 partners (nine Tokyo-based partners and four partners based in Singapore, Yangon and Bangkok) in the real estate team, plus three partners in the Japanese REITs (J-REITs) practice. Fifty other lawyers are also involved in real estate-related matters. The real estate practice extends from traditional acquisition and leasing transactions to complex fund structures involving a special purpose vehicle or a trust, or even investment structures for overseas properties. The team's work in this practice primarily includes private fund formation for domestic and overseas properties, J-REITs, real estate acquisition, development and disposition, and real estate financing. Recent highlights include advising GIC on the formation of a joint venture for hyperscale data centres, and acting for Daiwa House on establishing an open-ended fund to invest in logistic facilities.

The Civil Code provides the general legal framework for real property and real estate transactions, including ownership, co-ownership, superficies, easement and security interests, and for sale and purchase and leasing transactions.

In addition to the Civil Code, the Law on Unit Ownership of Buildings governs unit ownership (kubun shoyu ken) and the relationship among the unit owners of a multi-unit building, and the Land Lease and Building Lease Law applies to leases of buildings and leasehold interests or superficies in land for the purposes of owning a building on a parcel of land. Since this law was enacted to enhance protection of the tenant’s interest, some provisions are mandatory and cannot be circumvented by the parties to a land lease or building lease. Also, there are court rulings relating to land leases and building leases which have established legal doctrines that generally restrict the lessor’s rights and protect the tenants. Thus, when reviewing a lease of Japanese real property from a lessor’s perspective, one must remember that some contractual provisions may not work due to the mandatory provisions of the Land Lease and Building Lease Law, court rulings and established legal doctrines.

The Japanese real estate market has been active of late, even during the COVID-19 pandemic.

Although the pandemic has reduced the volume and speed of transactions to some extent, particularly for hotel and resort projects, the Japanese real estate market has been attracting increasing attention both domestically and from abroad. Compared to other countries, the market is underpinned by strong domestic demand and low interest rates. Also, many development projects for large-scale logistics properties and data centre facilities have been completed or are underway.

An increasing number of companies are developing and integrating proptech into their real estate services to streamline their business model and develop new opportunities. Real estate tech start-ups, including real estate crowdfunding platform providers, are expanding their presence in the market.

Several important reforms have been implemented in the last few years, the latest of which is the reform of the Civil Code (the Reformed Civil Code), which took effect on 1 April 2020, and the reform of the Real Estate Specified Joint Enterprise Law (the RESJEL), which took effect on 1 December 2017. The Reformed Civil Code has affected many aspects of real estate transactions since it amends various fundamental default rules in the area of the law of obligations. By virtue of the reformed RESJEL, certain real estate private funds using the widely used GK-TK structure (see 5 Investment Vehicles) in Japan could be exempted from the existing permit requirements when acquiring outright ownership of real property by fulfilling a different set of requirements.

For instance, the “Exempted Business (tokutei jigyo)” exemption requires the godo kaisha (GK – a limited liability company in Japan) to outsource the following:

  • the business operations of purchasing, selling, exchanging or leasing real estate to a real estate specified joint enterprise operator who has a permit under the RESJEL for those business operations (so-called Category 3 Operator); and
  • the solicitation activities for entering into tokumei kumiai (TK) agreements to a real estate specified joint enterprise operator who has a permit under the RESJEL for those activities (so-called Category 4 Operator).

In addition, if the GK is to conduct development or construction work, and the cost of such work shall exceed 10% of the fair value of the property relative to the TK business, TK investors must either have certain expertise and experience in real estate investments or be stock companies (kabushiki kaisha) whose paid-in capital is at least JPY500 million (such investors are “Professional Investors” in the context of the RESJEL). The detailed criteria for Professional Investors are set out in the ordinance under the RESJEL.

Another exemption, the “Qualified Exempted Investors-targeted Business (tekikaku tokurei toshika jigyo)” exemption, requires the GK to do the following, among other things:

  • outsource the business operations of purchasing, selling, exchanging or leasing real estate to a licensed real estate broker; and
  • obtain TK investments only from certain Professional Investors with a particularly high degree of expertise and experience in real estate investments (so-called Super Professional Investors).

The detailed criteria for Super Professional Investors are also set out in the ordinance under the RESJEL.

Real property under Japanese law includes land and any fixtures on the land – ie, buildings that may be traded independently from the land. Land and buildings are independent real properties and can be traded separately, so the owner of the land and the owner of the building standing on that land can be different people.

In the current Japanese market, the most common subject properties or interests for investment purposes are:

  • fee simple ownership of the land or the building, or both;
  • a combination of the right to use the land (leasehold interest or superficies) and fee simple ownership of the building;
  • co-ownership (kyo-yu) of the land or the building, or both; and
  • a combination of co-ownership of the land and unit ownership of private units in a multi-unit building.

Co-ownership refers to a type of ownership where one person owns a certain percentage interest in the entire property and other owners own the remaining percentage interests.

Unit ownership is a type of ownership recognised for a multi-unit building under the Law on Unit Ownership of Buildings. A unit owner is entitled to own exclusive private units in the building, to own and use common areas (such as the entrance hall of the building) jointly with other unit owners, and to use the underlying land in the form of ownership interests, leasehold interests or superficies.

In addition, many real properties are held under trust arrangements, in which case the investor would acquire a trust beneficial interest (TBI) in respect of the entrusted real property. Under a trust arrangement, the real property is owned by the trustee (usually, a licensed trust bank in Japan) as part of the assets of the trust, and the investor becomes a beneficiary of the trust by acquiring the TBI.

The Civil Code generally governs the transfer of title. Other laws may also be relevant, depending on the ownership structure. For example, the Law on Unit Ownership of Buildings provides for certain rules on the transfer of unit ownership.

Specific restrictions may apply to specific types of real estate. One such restriction is the requirement under the Agricultural Land Law that the acquisition of agricultural land is subject to governmental permission.

How to Effect a Title Transfer

A transfer of title to real estate is effected pursuant to an agreement between the seller and the buyer. Most sale and purchase agreements provide that the transfer of title takes effect upon the full payment of the purchase price by the buyer.

Registration of Title to Real Estate

Japan has a real estate registration (toki) system where title to and certain other interests (such as mortgages) on real estate are registered. In practice, parties to a real estate transaction usually rely on the real estate registration because it is generally the best indication of the true owner of or holder of interest on a real property.

Registration of a Title Transfer

A transfer must be registered pursuant to the real estate registration system in order for it to be perfected. If a transfer of real property is not registered, the buyer cannot assert its title against a third party.

Title Insurance

Title insurance is not commonly used in the Japanese real estate market.

A real estate due diligence process usually involves some or all of the following elements.

  • Document review – documents to be reviewed include publicly available materials such as a certified copy of the real estate registration, as well as the contracts that have been entered into in respect of the subject property. An “explanation sheet of important matters” (juyo jiko setsumei sho) prepared by a broker or the seller is usually one of the major documents that should be reviewed, as it is supposed to provide an orderly overview of the property (including pre-closing or post-closing requirements under public laws applicable to the transfer of the property) and highlight issues relating to the property.
  • On-site inspection – the buyer often retains, and brings to on-site inspections, an appraiser and a property inspector, who will prepare the necessary third-party reports.
  • Question-and-answer sessions – these are conducted in writing, through email, telephone or online meeting software, or at face-to-face meetings.
  • Third-party reports – for commercial real estate, the buyer often arranges for professional service providers to prepare a real estate appraisal report and an engineering report. It is not uncommon to ask lawyers to perform a legal due diligence investigation as well. Furthermore, if the buyer does not anticipate receiving any explanation sheet of important matters from the broker or the seller, then it is advisable for the buyer to retain a real estate adviser to prepare a property overview report to ascertain the various legal requirements applicable to the property.

Due diligence was not significantly affected by the COVID-19 pandemic. However, parties tend to use technology and avoid in-person meetings to prevent the spread of the virus.

Under the Civil Code, the seller is liable for any defect in the subject property. This defect liability may be limited by agreement on the scope, duration or amount of liability. Aside from such statutory liability, the seller and the buyer often agree on contractual representations and warranties regarding the subject property. This defect liability is referred to as “non-conformity liability” in the Reformed Civil Code.

The primary remedies for statutory liability and seller’s misrepresentations are termination of the purchase agreement and compensation for damages (or indemnity). Many sellers, however, negotiate the exclusion of the termination of the agreement as a post-closing remedy available to the buyer.

The primary laws relating to real estate transactions include the following:

  • laws governing private parties’ rights and obligations are the Civil Code, the Law on Unit Ownership of Buildings, the Land Lease and Building Lease Law, and the Real Estate Registration Law;
  • laws regarding regulations and public policy are the City Planning Law, the Construction Standards Law, the Soil Contamination Countermeasures Law, the Real Estate Transaction Business Law, and local government ordinances;
  • laws related to trusts and TBI transactions are the Trust Law, the Trust Business Law, and the Financial Instruments and Exchange Law; and
  • the Foreign Exchange and Foreign Trade Law relates to foreign investments.

The buyer may be responsible for soil pollution or environmental contamination of a property. If the soil contamination is likely to harm human health, the land will be designated as an area requiring action (yo sochi kuiki) under the Soil Contamination Countermeasures Law, and the landowner is required to take the necessary measures to remedy the contamination. The measures to be taken depend on the class of hazardous substances found on the land, and on the state and degree of contamination. In practice, the removal of contaminated soil is the prevailing remedial method.

That said, a prefectural governor may order the polluter, rather than the owner, to take the required countermeasures in the following circumstances:

  • if it is clear that the soil contamination was caused by that polluter, who is not the owner;
  • if the prefectural governor determines that it is appropriate for that polluter to take countermeasures; and
  • if the owner agrees.

The City Planning Law is the main source of zoning regulations. An “explanation sheet of important matters” prepared by a broker or the seller would address the zoning restrictions applicable to the subject property under the City Planning Law. A buyer may also consult with relevant governmental bodies to ascertain the applicable local or specific zoning or planning regulations.

The extent to which a project may involve dealing with governmental bodies varies significantly on a case-by-case basis.

The Land Expropriation Law provides the requirements and procedure for expropriation by governmental bodies of privately owned real estate. Owners of expropriated assets are generally entitled to reasonable compensation. The two major elements of the whole process are a confirmation that the project necessitating the expropriation serves the public interest, and the determination of the amount of compensation.

Asset Deal

The outright transfer of real property (asset deal) is subject to real estate acquisition tax (fudosan shutoku zei), registration and licence tax (toroku menkyo zei), consumption tax (shohi-zei) and stamp duty. Depending on the type of real property and the timing of the transactions, and subject to some exceptions, the tax rates are as follows:

  • registration and licence tax – 1.5% to 2% of the Taxable Base of the property, which is the property value recorded in the tax rolls for purposes of fixed assets tax;
  • real estate acquisition tax – 3% to 4% of the Taxable Base;
  • consumption tax – 10% of the purchase price of the building; and
  • stamp duty – up to JPY600,000 (or up to JPY480,000 under the current special tax treatment).

Corporation tax is also imposed on net income if the seller is a corporation.

Share Deal

In a share deal, corporate sellers are subject to corporation tax but not consumption tax, real estate acquisition tax, or registration and licence tax. Moreover, the share purchase agreement is basically not subject to stamp duty.

Allocation of Responsibilities for Taxes

Typically, the real estate acquisition tax, the registration and licence tax and the consumption tax are borne by the buyer, and the corporation tax is borne by the seller. The responsibility for the stamp duty is allocated based on agreement between the buyer and the seller.

Special Methods to Mitigate Tax Liability

For tax treatments that can be accomplished by using a trust structure or a tokutei mokuteki kaisha (TMK), please see 8.2 Mitigation of Tax Liability.

There are no legal restrictions on the acquisition of real property in Japan by non-residents, except that those buyers are required to make a post-transaction filing pursuant to the Foreign Exchange and Foreign Trade Law.

As further elaborated in 5 Investment Vehicles, there are three commonly used investment structures in real estate investments, and financing structures vary depending on the investment vehicles used for the transaction:

  • under the GK-TK structure, the acquisition is financed via TK and bank loans;
  • the financing instruments used for a TMK structure are preferred shares, “specified bonds” and “specified loans”; and
  • investment corporations or toshi hojin (J-REITs) issue equity units and bonds, and take out loans, to finance their real estate acquisitions.

Financing structures for share deals vary depending on the purpose and nature of the deal.

A mortgage is the most typical security interest created by a borrower who holds outright ownership of real estate. If the borrower and the lender intend to enter into financing transactions on a continual basis, a revolving mortgage may be created instead. If the borrower holds an interest in real estate in the form of a TBI, a pledge over the TBI is the principal security interest in place of a mortgage. Some lenders may require pledges over insurance claims.

There are no special restrictions on granting security over real estate to foreign lenders. However, a licensing requirement applies if a foreign financial institution lends money in Japan as part of its money lending business, unless the institution is a licensed bank in its home country and has a Japanese branch. Thus, foreign institutions that do not satisfy those requirements often consider purchasing bonds, rather than making loans. Investors must note that bonds issued by Japanese corporations must be unsecured, unless special procedures are taken in accordance with the Secured Bond Trust Law.

Interest payments to non-resident lenders are generally subject to withholding taxes.

Formal (ie, non-provisional) registration of a mortgage is subject to a registration and licence tax, at a rate of 0.4% of the secured amount. Because this tax can be substantial depending on the secured obligation, some lenders permit the borrower to make a provisional registration only, which costs JPY1,000 for each real property. Once the mortgage is formally registered based on the provisional registration, the mortgagee enjoys priority over other mortgagees who register their mortgages after the provisional registration. However, provisional registration is of little use unless formal registration is completed based on the provisional registration. Therefore, lenders need to ensure that they are always in possession of all documents necessary to allow them to formally register the mortgage. 

Judicial foreclosure of a mortgage involves various costs. The applicant has to prepay up to JPY2 million (in the case of the Tokyo District Court) to a competent court, which will be credited to the court’s expenses.

If there are minority shareholders in a company that is providing security to secure a debt owed by its parent company, the directors of the security provider usually obtain the consent of said minority shareholders to ensure that the directors are not deemed to be in breach of their fiduciary duty and duty of care.

In the case of a borrower’s default, a mortgagee would typically accelerate the entire outstanding debt pursuant to the credit agreement. After the secured obligation becomes due, the mortgagee may judicially enforce the mortgage by submitting the real estate registration certificate on which the mortgage is registered. The priority of the mortgage vis-à-vis other mortgages is determined based on the order of mortgage registration.

Unless the existing lenders with perfected security interest agree, they do not become subordinated to any newly created non-preferred debt.

Because a financer such as a lender is not an “owner” for purposes of the Soil Contamination Countermeasures Law, a lender is not responsible for soil contamination investigations and countermeasures, unless it acquires the land from the borrower in default through the enforcement of a security.

According to a notice issued by the Ministry of Environment, even if the borrower assigns its land to a lender for the purpose of security (joto-tampo), the borrower but not the lender is deemed to be the “owner” of the land and will be responsible for any investigations and countermeasures under the Soil Contamination Countermeasures Law.

The creation of a security interest by a financially distressed borrower may be invalidated (by the insolvency trustee or the debtor-in-possession under the theory of bankruptcy avoidance) if the security interest was created to secure existing debt: 

  • after the filing of an insolvency petition with respect to the borrower (and the creditor knew that the petition had been filed); 
  • during the period when the borrower is “unable to pay” (ie, unable to pay its debts generally when they fall due) (and the creditor knew that the borrower was unable to pay, or that the borrower did not pay its debts generally when they fell due); or
  • 30 days or less before the borrower became “unable to pay”, and the borrower voluntarily created such security interest in favour of a specific creditor (and the creditor knew that such creation of security would prejudice other creditors). 

The perfection of a security interest may also be avoided even where the creation of a security interest itself may not be avoided, pursuant to the criteria set out above. This is to prevent the holder of a security interest that has been hidden for a long time from obtaining priority over general creditors after the borrower gets into a financial crisis. The requirements of such avoidance include the perfection being made after the suspension of payments or the filing of an insolvency petition, and not being made within 15 days of the creation of the security interest.

The Tokyo Interbank Offered Rate (TIBOR) is widely used as a benchmark to determine the base rate for floating interest rates, so the expiration of the LIBOR index is not really expected to have a significant impact on real estate financing transactions in Japan.

The City Planning Law is the main source of planning and zoning regulations. Local ordinances are also relevant.

The Construction Standards Law is the primary law regulating the construction of new buildings and the refurbishment of existing buildings. The law establishes minimum standards concerning building sites, structures, equipment and building use.

Under the Construction Standards Law, the confirmation of authorised entities regarding the details of construction or refurbishment must be obtained for the construction of new buildings or any major refurbishment of existing buildings. Authorised entities include local governments such as cities, towns and villages, and private building agencies accredited by the government.

A building developer or building owner must apply for confirmation from the relevant local governments or government-accredited private building agencies. The detailed requirements for such confirmation, including the steps to be taken vis-à-vis third parties, may differ under the relevant local ordinances.

Theoretically, it is not impossible to litigate against an authority’s decision, although such litigation is not commonly seen in practice.

Unless the development project involves a property or facility that is currently or was previously owned by a governmental body, it is not common to enter into agreements with governmental bodies to facilitate a development project.

The contractor of a building under construction in violation of the Construction Standards Law or the City Planning Law, or the owner of a building that has been thus constructed, may be ordered to suspend the construction or to demolish or refurbish the building, or otherwise to ensure compliance of the building with legal requirements.

Generally speaking, real property tends to be owned directly by joint stock companies (kabushiki kaisha or KK), which is the most popular form of corporate entity available under the Companies Law.

When it comes to real estate investment, there are three typical investment structures: the GK-TK structure, the TMK structure and the J-REIT structure, each of which uses a different type of entity to acquire property.

Among these three structures, the GK-TK structure and the TMK structure are primarily used to acquire a specific asset or portfolio identified at the outset. The TMK structure is more often preferred by non-Japanese investors.

However, the J-REIT is used as a going-concern vehicle for real estate investment, the asset portfolio for which can be continually expanded or replaced with new assets. 

The main features of each structure are discussed below.

GK-TK Structure

A GK-TK structure usually involves three types of vehicles:

  • the fund is formed as a limited liability company (godo kaisha or GK);
  • the GK is to acquire and hold one or more TBIs in a real estate trust (Property Trust); and
  • the GK obtains quasi-equity investment from a TK investor under a TK agreement, and takes out a loan from a third-party financial institution.

A GK is one of the ordinary corporate forms available under the Companies Law, with all equity holders (members) of the GK bearing limited liability. As there is no specific minimum capital requirement, the paid-in capital of a GK is usually nominal (such as JPY100,000).

For tax and other regulatory or practical reasons, real property is often traded under trust arrangements in Japan – ie, property is acquired in the form of a TBI rather than an outright purchase of the property. In that case, the real property is owned by the trustee of the Property Trust (usually, a licensed trust bank in Japan) for the benefit of the GK as beneficiary.

A TK is one of the forms of partnership available under the Commercial Code, and is formed by an agreement between the GK as operator and a TK investor. As a legal matter, the funds contributed by the TK investor belong to the GK as operator, and all acts of the TK business are done in the name of the GK.

TMK Structure

A tokutei mokuteki kaisha (TMK) structure involves a specified purpose company, which is a corporate entity specifically designed to acquire a specific asset (such as real estate assets) by issuing asset-backed securities under the Asset Liquidation Law. 

The best feature of a TMK is that, by fulfilling certain requirements, it will be eligible for special favourable tax treatment that is not available to a KK or a GK. The downside is the imposition of various regulatory requirements and special restrictions under the Asset Liquidation Law.

In most cases, a TMK finances the acquisition of real estate assets (which can be actual real properties or TBIs) by issuing preferred shares and obtaining third-party debt.

The TMK’s equity consists of “specified shares” and “preferred shares”, with no minimum capital requirement. Specified shares are similar to ordinary voting shares of a KK. The amount of specified shares is nominal and is not supposed to be used for the acquisition of real estate assets, and the preferred shares comprise most of the TMK’s equity.

The third-party debt is usually obtained in the form of “specified bonds” or “specified loans”.

J-REIT Structure

A J-REIT is a type of investment fund in a corporate form under the Investment Trust and Investment Corporation Law, which is set up to acquire real estate assets (whether actual real properties or TBIs).

Similar to a TMK, a J-REIT can be eligible for special favourable tax treatment that is not available to a KK or a GK, but it is subject to various regulatory requirements and restrictions under the Investment Trust and Investment Corporation Law.

A J-REIT’s equity is issued in the form of investment units, and the minimum equity requirement is JPY100 million.

The investment units of a J-REIT can be listed and traded on a stock exchange. As of 31 January 2021, there were 62 publicly listed J-REITs in Japan.

Please see 5.1 Types of Entities Available to Investors to Hold Real Estate Assets.

Please see 5.1 Types of Entities Available to Investors to Hold Real Estate Assets.

Governance requirements vary, depending on the structure.

GK-TK Structure

The governance of a GK is simpler and more flexible than a KK, and the characteristics of the operations and governance of a GK are intended to be more similar to those of a limited partnership. In most cases, a GK is incorporated with one corporate entity being the sole managing member representing the GK, and such managing member appoints an individual (operating manager or shokumu shikkosha) to act as its representative and perform the duties of a managing member.

In a GK-TK structure, the GK is structured as a special purpose company that has no human resources. Thus, it is intended for the GK to retain an asset manager, who takes a lead role in the GK’s activities. Such asset manager must be a registered investment adviser or manager under the Financial Instruments and Exchange Law.

TMK Structure

A TMK must always have at least one director and one statutory auditor. In addition, one accounting auditor is usually required to be appointed, who must be either a certified public accountant or an auditing firm.

Certain fundamental matters with respect to a TMK require the approval of its shareholders (in the form of a resolution). In general, only specified shareholders have voting rights at shareholders’ meetings.

The management and disposal of the real estate assets owned by the TMK must be subcontracted to a third party, which must be a trust company or certain other service provider experienced in asset management and permitted under the Asset Liquidation Law. In practice, there are two types of asset management, depending on whether the TMK acquires actual real properties or TBIs:

  • actual real properties – the TMK needs to retain an asset manager who is licensed to engage in a real estate transaction business under the Real Estate Transaction Business Law; or
  • TBIs – the trustee of a Property Trust is responsible for the management and disposal of the real estate assets, and the TMK needs to retain an asset manager who is a registered investment adviser or manager under the Financial Instruments and Exchange Law.

J-REIT Structure

A J-REIT must have at least one corporate officer, supervisory officers outnumbering the directors (by at least one person), a board of officers and an accounting auditor, which must be either a certified public accountant or an auditing firm.

The fundamental matters with respect to a J-REIT are quite limited, and require the approval of its unitholders (in the form of a resolution).

Pursuant to the Investment Trust and Investment Corporation Law, a J-REIT must retain the following:

  • an asset manager who is a registered investment manager under the Financial Instruments and Exchange Law and a licensed real estate transaction business provider with a discretionary agency permit under the Real Estate Transaction Business Law;
  • an asset custodian; and
  • an administrative agent.

Maintenance costs vary significantly on a case-by-case basis. However, generally speaking, the following applies:

  • the cost to maintain a TMK structure is higher than for a GK-TK structure;
  • the cost to maintain a J-REIT structure is significantly higher than for a GK-TK structure or a TMK structure; and
  • the cost to maintain a publicly listed J-REIT is higher than for a private J-REIT.

Leases are the most common arrangements by which to use another person’s land or building, but superficies (chijo-ken) is a common alternative. 

The purpose of a lease is not limited, and leases are available for both land and buildings. In contrast, superficies is available only to own buildings or trees. 

In general, holders of superficies are in a stronger position than leaseholders against the landowner, as they are holders of a “real right”. For instance, the landowner owes the superficies holder a duty to co-operate in the registration of the superficies which is required for perfection, but the lessor does not owe such a duty to the tenant.

There are two types of land or building leases based on the lease term – namely, a general lease and a fixed-term lease. 

A general lease is subject to renewal, which the lessor is entitled to refuse only when there is a justifiable reason, taking into account the lessor’s and the tenant’s respective needs to use the property, the history of the lease, the present use of the property, and the amount of compensation being offered by the lessor to the tenant to vacate the property.

A fixed-term lease allows for three alternative arrangements for land leases (each a “Fixed-Term Land Lease”), as follows:

  • those relating to land on which a building is built for business or residential purposes and that have a term of at least 50 years are not renewable, and must be executed in writing;
  • those relating to land on which a building used only for business purposes (ie, not for residential purposes) is built and that have a term of at least 30 years but under 50 years are not renewable, and must be executed by way of notarial deeds; and
  • those relating to land on which a building used only for business purposes (ie, not for residential purposes) is built and that have a term of at least ten years but under 30 years are not renewable, and must be executed by way of notarial deeds (a “Category 3 Fixed-Term Land Lease”). 

A “Fixed-Term Building Lease” is also available. This lease must be in writing, is not renewable and will terminate upon the expiry of the lease term.

General Lease

In a general lease for land or buildings, lease terms that are contrary to or reduce certain statutory protections or rights granted to the tenant under the Land Lease and Building Lease Law are void. These statutory protections and rights include the following:

  • the lessor must have a justifiable reason to refuse a renewal of the lease; 
  • the tenant may demand that the rent be decreased in response to market conditions, and cannot be deprived of the right to demand a decrease of the rent even if they explicitly agree not to exercise that right;
  • in the case of a land lease only, the leasehold interest in the land is perfected without registration if the land tenant owns a registered building on the leased land;
  • in the case of a land lease only, the land tenant has the right to request the landlord to purchase the building upon the termination of the land lease; and
  • in the case of a building lease, the leasehold interest in the building is perfected without need of registration if the leased building is delivered to the tenant.

Otherwise, the rent and other terms of the general lease are freely negotiable and not regulated or subject to a voluntary code. 

Fixed-Term Lease

The tenant may be deprived of the protections and rights under the first and fourth items listed above under a Fixed-Term Land Lease, and of the protections and rights under the first and second items under a Fixed-Term Building Lease.

COVID-19 Pandemic Legislation

The Japanese government enacted the following special measures, under certain conditions, for lessors to address the impact of the COVID-19 pandemic on lessors’ business:

  • if the lessors and their tenants agree to reduce rent, the difference may be treated as a tax-deductible expense;
  • lessors can apply for the deferral of national and local taxes and social insurance premiums; and
  • fixed asset and city planning taxes for 2021 can be reduced to zero or halved.

On 31 March 2020, the Ministry of Land, Infrastructure and Transport requested lessors to be flexible in responding to their lessees’ requests, for such matters as rent deferral, if the lessees were having difficulty paying rent due to the pandemic. This is not a legally binding order and there is no penalty for rejecting such requests.

Also, tenants that are small or medium-sized enterprises or individuals can receive certain cash benefits from the Japanese government on the ground of a substantial decrease in sales.

The initial term of a land lease for owning a building is required by law to be at least 30 years, and tends to range from 30 years to 50 years, except where the land lease is a Category 3 Fixed-Term Land Lease. 

Building leases are typically for a much shorter term. Office space leases are often for a short term (most commonly two to five years), while building leases for retail or commercial facilities tend to be longer, for ten to 20 years. 

The maintenance and repair of the premises actually occupied by the tenant are typically the responsibility of the tenant. However, if certain renovation works are required by the tenant before it can start using the premises, the allocation of the responsibility and the cost for such works is negotiated before entering into the lease agreement.

Monthly payment is the most typical payment term.

It is not common in Japan for lease agreements to address issues relating to the COVID-19 pandemic or other future pandemics, except in cases where parties have agreed on special treatment for these events, such as expanding the definition of force majeure to include the COVID-19 pandemic.

Lease agreements usually schedule a regular rent review, which is conducted every three to five years in many cases. During a rent review, the parties will negotiate an increase or decrease in the rent for the next three to five years.

Aside from a contractual rent review, the Land Lease and Building Lease Law entitles either party to a lease to demand that the rent be increased or decreased in response to market conditions. If the parties cannot come to an agreement, a court may order an adjustment after considering the following: 

  • any change in tax or other liabilities imposed on the leased real estate (or the underlying land in the case of a building lease); 
  • the value of the leased real estate (or the underlying land in the case of a building lease), and other relevant economic conditions; and 
  • rents in neighbouring areas. 

If the court determines that the rent should be decreased, the lessor will be ordered to return any excess rent and pay interest at the rate of 10% per annum on the excess amount.

If the lessor and tenant specifically agree not to increase the rent for a certain period, the lessor cannot exercise its right to demand an increase in the rent but, with respect to a land lease and a general building lease, the tenant cannot be deprived of the right to demand a decrease in the rent, even if it has explicitly agreed not to exercise that right under the lease. 

However, a different rule applies to a Fixed-Term Building Lease, under which the lessor and the tenant may exclude the application of the rule on rent adjustment described above by setting forth express provisions on rent revisions.

Please see 6.5 Rent Variation.

Consumption tax (which is equivalent to VAT) is payable on the rent on building leases other than for residential purposes. The rent on land leases is exempted from consumption tax.

Typical costs payable by a tenant at the start of a lease include a deposit (often calculated by a multiple of the monthly rent, depending on the type of lease and the real estate), brokerage fees, insurance premiums and other expenses, such as for replacement of the keys.

The maintenance and repair costs of common areas are paid by the building owner, primarily from the money paid by tenants as common area fees.

Utilities and telecommunications serving a property occupied by several tenants are paid for by the building owner, primarily from the money paid by tenants as common area fees.

Typically, a tenant pays for insurance covering damage caused by accidents occurring in the real estate and by fire and, in some cases, earthquake and flood.

There may be contractual restrictions on how a tenant uses the real estate, restrictions on the use of common areas, and prohibitions on the handling of hazardous materials or explosives.

The extent to and the conditions under which the tenant is permitted to alter or improve the real estate are entirely up to the agreement between the lessor and the tenant.

In principle, there are no specific regulations or laws that apply to leases of particular categories of real estate.

The Act on Special Measures against New Influenza was amended in 2020 so that it can be applied to the COVID-19 situation. The reform of the Act took effect on 13 February 2021.

Under the reformed Act, the governor of the prefecture with jurisdiction over certain facilities can request or order such facilities to close, and can impose fines for breach of such order. The prefectural governor also has discretion to identify the target area and facilities, and other details of the request.

In the case of a bankruptcy procedure (hasan tetsuzuki) or a corporate reorganisation procedure (kaisha kousei tetsuzuki), a bankruptcy trustee – or a debtor in possession in the case of a civil rehabilitation procedure (minji saisei tetsuzuki) – has a statutory right to determine whether to terminate the lease agreement or to continue the lease by performing its obligations. 

If the bankruptcy trustee of the tenant or the tenant as debtor in possession opts for the termination of the lease, the treatment of the unpaid rents depends on when the due date arose: unpaid rents accruing before the commencement of the relevant insolvency procedure are treated, in principle, as general insolvency claims and are therefore subject to the insolvency procedure and subordinated to preferential claims, while rents that become due after the commencement of the insolvency procedure are paid from the insolvency estate in preference to other general insolvency claims, and are not subject to the insolvency procedure. 

If continuation of the lease is chosen instead, unpaid rents accruing before the commencement of the relevant insolvency procedure would be treated as general insolvency claims, although there is a different academic view that treats such unpaid rents as preferential claims. Furthermore, if the lease is continued, the rents that are due on or after the commencement of the relevant insolvency procedure are paid from the insolvency estate in preference to other general insolvency claims. 

In practice, lease agreements often provide for the lessor’s right to terminate the lease upon the commencement of an insolvency procedure on the part of the tenant. However, there are a few legal precedents that reject such a contractual provision, so the validity of such a provision remains arguable and, in practice, it is widely understood that the lessor should not rely on such a provision.

Furthermore, if the tenant is subleasing the leased property to a person who holds a leasehold interest that is perfected, then the above-mentioned statutory right of the bankruptcy trustee (and the debtor in possession) does not apply vis-à-vis the subtenant. If the insolvent tenant chooses to terminate its lease vis-à-vis the landlord, it inevitably causes a breach of its obligation to lease vis-à-vis the subtenant. Therefore, in practice, the insolvent tenant may not be able to opt for the termination of the lease if it is subleasing the leased property.

Typically, a tenant is required to pay a deposit at the start of the lease as security for any failure to pay in the future. A typical lease agreement contains a provision that allows the landlord to utilise the deposit to cover any outstanding obligation of the tenant.

A tenant is obliged to vacate and return the leased property on or before the expiration or termination of the lease term if the lease is not renewed. Lease agreements typically provide for the payment of liquidated damages in the form of monthly rents equal to twice the last agreed monthly rent, for the period from the day after the expiry or termination of the lease term up to the day the tenant actually vacates the leased real estate. 

Generally, the lessor does not have to do anything to ensure that the tenant vacates the property on time, as long as the lease duly expires or terminates. However, there is a special requirement in a Fixed-Term Building Lease that the lessor must provide written notice of the expiry of the lease term from one year to six months prior to the expiry date in order to oblige the tenant to vacate the leased property by the end of the lease term.

A tenant may assign its leasehold interest in the lease or sublease all or a portion of the leased premises if it is able to obtain the owner’s approval.

Typically, lease agreements provide that the following events give the landlord a right to terminate the lease:

  • breach of obligation by the tenant, such as failure to pay rent;
  • commencement of an insolvency procedure by the tenant;
  • the occurrence of events that constitute grounds for the commencement of an insolvency procedure, such as being “unable to pay” (ie, unable to pay debts generally when they fall due); and
  • the issuance of an order for compulsory execution, petition for auction sale or compulsory disposition for delinquent public charges.

Having said this, the court takes the view that the lessor is entitled to terminate the lease only if the tenant’s breach amounts to a destruction of the relationship of trust between the lessor and the tenant, regardless of any provision in the lease agreement. Therefore, in practice, it is widely accepted that the lessor will not be able to terminate the lease simply by relying on the termination provision of the lease agreement. 

A statutory right to terminate in the case of the tenant’s insolvency is discussed in 6.15 Effect of the Tenant's Insolvency.

A Fixed-Term Land Lease and a Fixed-Term Building Lease must be made in writing (see 6.2 Types of Commercial Leases). 

A leasehold interest in the land must be registered pursuant to the real estate registration system in order for it to be perfected. However, if the lessee own a building standing on the land, the lessee may perfect its leasehold interest in the land by registering its ownership of the building. 

A leasehold interest in a building could also be perfected by either registering it pursuant to the real estate registration system or upon the delivery of the subject building by the landlord to the tenant, in which case the tenant can assert its leasehold interest against any person who acquires the building after delivery. 

Registration of a leasehold interest is subject to a registration and licence tax at the rate of 0.4% of the Taxable Base of the property. In general, it is the tenant who pays the registration and licence tax.

In order to force a tenant to leave, the lessor must first obtain a court judgment ordering the tenant to vacate the leased property on the basis of the termination of the lease. If the tenant does not comply with the judgment, the lessor will need to file a petition for compulsory enforcement against the tenant to compel it to surrender the leased property. 

The length of time necessary to obtain such a judgment and to complete a compulsory enforcement largely depends on the tenant’s response in court hearings and the tenant’s reaction to the requirement to surrender, and varies from a few months to one year.

Leases cannot be terminated by any third party, including central government or municipal authorities.

The most typical construction price structure is the fixed price arrangement, whereby the parties agree on the price at the signing of the construction contract, taking into account estimated costs and expenses as well as the contractor’s profit. For a large construction project, the price adjustment mechanism may be implemented to reflect fluctuating procurement prices of materials or services linked to the cost element of the construction price.

Typically, design and construction works are provided under separate independent agreements – ie, the owner tends to enter into a design contract with a design company and a construction contract with a construction company. Each contract’s terms and conditions are usually prepared and negotiated based on general terms and conditions made available as templates by the pertinent industry associations in Japan.

The general terms and conditions of a typical construction contract that are made available jointly by the pertinent industry associations (the “Form Terms and Conditions for Construction Contracts”) provide for the construction contractor’s obligation to take out insurance, and for defect liability. This defect liability is referred to as “non-conformity liability” in the Reformed Civil Code.

With respect to insurance, the Form Terms and Conditions for Construction Contracts require the contractor to purchase and maintain fire insurance or contractor’s all risk insurance for the completed portion of the work, materials and building equipment and other materials delivered to the construction site. The details of the insurance coverage are left for the parties to agree.

With respect to defect liability, the Form Terms and Conditions for Construction Contracts provide that the owner may demand that the contractor repairs the defect, reduces construction fees, and/or pays damages. In principle, the contractor’s liability is subject to a time limitation of one to two years, depending on the construction materials (such as wood, stone, metal or concrete). However, in the case of a newly constructed residential building, the defect liability period for certain major structural works is mandatorily set at ten years after the delivery of the building, pursuant to the Housing Quality Assurance Law, a special law to ensure the quality of residential buildings.

Schedule-related risks can be managed by the payment of liquidated damages by the contractor. Such contractual arrangements are allowed under Japanese law, and the courts are bound by the amount of liquidated damages agreed, without having to ascertain the actual damages incurred. 

In particular, the Form Terms and Conditions for Construction Contracts provide that if the contractor fails to deliver the completed work by the due date for any reason attributable to the contractor, the owner may claim liquidated damages calculated at 10% per annum of the agreed construction price (minus a portion of the construction price equivalent to the part of the work already completed and delivered), calculated on the basis of the number of days delayed.

On the other hand, the Form Terms and Conditions for Construction Contracts allow the contractor to seek an extension of the due date if there is any justifiable reason, such as a force majeure event or a need for adjustment of the works. If the delay is caused by any reason not attributable to the contractor and the owner agrees to extend the due date, the owner is not entitled to liquidated damages.

For domestic construction projects, additional forms of security such as performance bonds or parent guarantees are not common. Normally, it is difficult to get major construction companies to provide additional security.

The law grants contractors the right to retain (ryuchi ken) or refuse to deliver the completed building in the event of non-payment, as long as the contractor has possession of the building. This right to retain does not require any registration.

Construction contracts typically provide for the payment of the last instalment of the construction price in exchange for the delivery of the completed building.

The Construction Standards Law requires the owner to obtain an inspection certificate (kensa zumi shou) before it is allowed to use a newly constructed building. The process is as follows:

  • the owner must apply for inspection by the relevant local government or government-accredited private building agency within four days of the completion of the construction; 
  • the inspection will be carried out within seven days of the application being accepted; and 
  • if it is confirmed that the construction and the site comply with relevant laws and regulations, the inspection certificate will be issued.

The sale of a building is subject to consumption tax (equivalent of VAT) at the rate of 10% of the purchase price of the building. The sale of land is not subject to consumption tax.

Although the seller is liable for the consumption tax under tax law, in practice the buyer is contractually obliged to pay an amount equivalent to the consumption tax on top of the purchase price of the building. 

In general, sellers whose taxable sales did not exceed JPY10 million in the penultimate taxable year are exempt from consumption tax.

The most common method to mitigate tax liability is to use a trust structure where the investor purchases the TBI in a Property Trust rather than the outright ownership of the real property itself. Please also see 2.1 Categories of Property Rights and 5.1 Types of Entities Available to Investors to Hold Real Estate Assets

In doing so, generally:

  • the registration and licence tax for the establishment of a Property Trust is reduced from 1.5% (for land) or 2.0% (for buildings) of the Taxable Base of the property (which is applicable in an outright purchase of real property) to 0.3% (for land) or 0.4% (for buildings) of the Taxable Base of the property. In addition, JPY1,000 is paid for each TBI transfer; and
  • the real estate acquisition tax is reduced from 1.5% (for building land), 3.0% (for non-building land and residential buildings) or 4.0% (for non-residential buildings) of the Taxable Base of the property (which is applicable in an outright transfer of real estate) to zero.

Alternatively, by using a TMK as an acquisition vehicle, the registration and licence tax is reduced to 1.3% of the Taxable Base of the property, and the real estate acquisition tax is effectively reduced to 0.6% (for building land), 1.2% (for non-building land and residential buildings) or 1.6% (for non-residential buildings) of the Taxable Base of the property because, in computing real estate acquisition tax, the TMK is allowed to reduce the Taxable Base of the property to 40% of the regular taxable base.

In Japan, no universal municipal taxes are paid on the occupation of business premises, except in certain major cities, where taxes (of a relatively low amount) are imposed on the basis of the size of the taxpayer’s premises or the amount of salaries paid. 

The main municipal taxes paid on real estate per se are a fixed asset tax (kotei shisan zei) and a city planning tax (toshi keikaku zei), which are imposed on every owner of real estate, irrespective of its purpose. However, there are limited exemptions for the above municipal taxes in certain designated areas where the municipal government is promoting certain industry sectors.

Income Tax Withholding for Foreign Investors

There is income tax withholding for non-resident individuals and foreign corporations. 

Taxation on Rental Income

Rental income from real estate is subject to corporation tax if the lessor is a foreign corporation, or to income tax if the lessor is a non-resident individual. In 2021, the applicable corporation tax rate is 15% (for small income of a small enterprise) or 23.2% (in other cases), plus a local corporation tax of 10.3% of the amount of the corporation tax and a special corporation enterprise tax of various rates, while the applicable progressive income tax rates range from 5% to 45%, plus a special income tax for reconstruction, at 2.1% of the amount of the income tax. 

If the lessor is a non-resident individual or foreign corporation, the tenant is required to withhold 20.42% of the rent, payable to the tax authority no later than the tenth day of the month following the date of the payment of the rent. Withholding is not required if the tenant is a natural person using the property as a residence for himself or his relatives. Any amount withheld by the tenant from the rent can be used as a deduction for corporation or income tax.

There is no exemption for taxation on rental income from real property in Japan.

Taxation on Gains from the Disposition of Real Property

Capital gains from the disposition of real property in Japan are subject to corporation or income tax in the same manner as rental income, as described above.

If the owner of the real property to be sold is a non-resident individual or foreign corporation, the buyer is required to withhold 10.21% of the purchase price, payable to the tax authority no later than the tenth day of the month following the date of payment of the purchase price. Withholding is not required if the purchase price does not exceed JPY100 million and the buyer will use the property as a residence for himself or his relatives. Any amount withheld by the buyer from the purchase price can be used as a deduction for corporation or income tax.

There is no exemption for taxation on capital gains from the disposition of real property in Japan.

A depreciation deduction is available for a person who owns a building. The depreciation expense is allocated to each taxation year equally or by a declining rate for the life of the building as prescribed by law, depending on the structure and purpose of the building. Land is not a depreciable asset.

Mori Hamada & Matsumoto

Marunouchi Park Building
2-6-1 Marunouchi
Chiyoda-ku
Tokyo 100-8222
Japan

+81 3 6212 8330

+81 3 6212 8230

mhm_info@mhm-global.com www.mhmjapan.com
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Trends and Developments


Authors



Nishimura & Asahi has substantial experience in a wide array of real estate securitisations in both domestic and cross-border transactions. The firm's real estate finance team has a proven track record in advising both lenders and borrowers in finance transactions throughout the real estate industry, offering expert assistance to clients in all stages of their transactions, from the term sheet and structuring stage through closing, tranching, syndication and securitisation, administration, servicing and, if required, restructuring. Since the early 2000s, the firm's lawyers have played a significant role in advising publicly traded REITs, private REITs, and real estate operating and finance companies in all stages of their life cycles, from REIT formation, roll-up transactions and initial public offerings to secondary debt and equity offerings, and REIT transactions. Nishimura & Asahi advises on real estate sales and purchases, investment, lease and management in Japan and abroad; as the growth in real estate funds and private equity investment in real estate increases, the firm has been advising all of the key fund-related specialties. Furthermore, the firm specialises in environmental law, providing risk analysis and settling disputes on soil pollution, asbestos and other environmental law issues that arise regarding real estate; capabilities extend to environmental law-related issues to be complied with by business entities and corporate social responsibility (CSR).

COVID-19’s Impact on the Market

The COVID-19 outbreak had a significant impact on the real estate market, as it did on many other business sectors. However, its impact varied significantly depending on the real estate asset type.

Logistics

There has been a trend of increasing investment in the logistics area in recent years. The outbreak seems to be significantly accelerating this trend due to the expansion of e-commerce as a result of the widespread adoption of work-from-home arrangements and the quarantine measures imposed during the state of emergency. More investors and real estate funds have focused on logistics, especially those fitted to the rapidly updated technology of digital transformation (DX) from an e-commerce viewpoint.

There have been a number of logistics deals this year, including an investment by a foreign fund in a portfolio of newly built logistic facilities (over USD550 million) developed by a well-known Japanese developer, and the establishment of several private J-REITs focused on logistics properties. This trend seems likely to continue after the outbreak has passed.

Office and residential properties

Despite the pandemic, investment in office and residential properties in Japan seems to be steady, due to a combination of several factors including the quantitative easing policy, a relatively less severe number of infections compared to other markets and the relative difficulty for tenants to reduce rent under Japanese law (see Building Lease below). Specifically, the vacancy rate in high-quality assets in the Tokyo area has not risen as much as initially expected. One reason for this may be that the average rent rates for those high-class assets has been increasing in recent years and the rent prices of lease agreements ending in this year (which, in many cases, had been agreed upon in the aftermath of the financial crisis) still often look relatively low, so lessees are unwilling to terminate those contracts at this point.

There have been several impressively sized inbound transactions: a US-based fund invested more than USD1 billion in office and commercial properties and more than USD2.8 billion in a residential portfolio, and a Switzerland-based global insurance company invested more than USD1.2 billion in a residential portfolio (consisting of approximately 80 properties) in its first investment in Japan. In addition to these private funds, there is an established J-REIT market with a steady appetite for office and residential properties.

Hotels and accommodations

The pandemic has clearly had a negative effect on the hotel and accommodation market, including some J-REITs mainly focused on hotel assets. In contrast to office and residential properties, the cash flow of hotel properties is easily affected as a result of a drastic decrease in tourism. Although the Japanese government did support the travel market by providing a subsidy for domestic travel (the so-called “Go to campaign”, under which customers received a certain percentage of tour costs from the Japanese government), this support did not make up for the negative effect of the outbreak on the cash flow of these assets. Consequently, asset prices seem to be decreasing, with investments in this sector shrinking this year.

Some mezzanine financing deals have taken place under these circumstances. From an owner’s viewpoint, bridge financing may be an inevitable way to make up such damaged cash flows. On the other hand, financing providers may expect that the financing would lead to a potential opportunity to take over the assets after the COVID-19 situation is resolved. Accordingly, there may be an increase in the acquisition of hotels and accommodations, and in the restructuring of financing for such properties.

Building Lease

A lessee’s rights are basically protected under the Act on Land and Building Leases (Act No 90 of 1991 – the Lease Act). As a general rule, upon the lapse of the term of a normal lease, the building lease contract will be renewed under the same terms and conditions as an existing contract. A lessor may not terminate a normal lease unless it has justifiable grounds for giving a termination notice to a lessee. Please note, however, that these rules are not applicable to “fixed term” leases.

Also, generally, rent will not be revised for a normal lease unless there is a provision for automatic rent adjustments or if changes are separately agreed upon between a lessor and lessee. The Lease Act grants both lessor and lessee a statutory right to claim increases or decreases to rent under a normal lease where the rent becomes unreasonable due to a change in taxes or other factors relating to the lands and buildings, or due to fluctuations of economic circumstances (including a rise or fall in property prices), or in comparison with rents in other similar leases. It is not clear, however, whether COVID-19 constitutes grounds for a lessee to assert this statutory right to claim decreased rent, considering that overall property prices have not seen a material drop in Japan. Please note that this statutory right does not apply to a fixed term building lease if both parties have agreed otherwise.

In general, building rents have not fallen significantly, despite the turbulence caused by COVID-19, although certain tenants have requested that lessors voluntarily decrease rent for a certain period of time as a form of rent relief, to help lessees manage decreased business income. In relation to such trends, the Ministry of Land, Infrastructure, Transport and Tourism (the MLIT) delivered a notice in March 2020 asking real estate-related organisations to take flexible measures, such as rent reduction, by giving due care to tenants who were struggling due to COVID-19. However, such notice does not provide tenants with any legal rights to a rent reduction.

Digital Transformation

DX technology in the real estate market in Japan has been actively developed in this decade, and increasing demands corresponding to the COVID-19 outbreak are further accelerating the development.

Logistics

Logistics properties adopting cutting-edge DX technology are attracting investments from many domestic and foreign investors and real estate funds. Existing logistics facilities are facing problems in handling logistics operations corresponding to the expansion of e-commerce during the COVID-19 pandemic, and DX technology is expected to help with issues such as efficient operations of facilities and supply chains.

Mobility as a Service (MaaS) is a potential field that would utilise traffic data to efficiently operate logistics. While there is no integrated legislation for MaaS, other than a government guideline regarding MaaS-related data collaboration published in March 2020, the Japanese government is actively working on demonstration projects for “Distribution MaaS” with some private companies, which were announced in July 2020. The trend of private companies updating their logistics facilities with DX technology also seems to be continuing.

Smart City

Smart City measures are being implemented in several cities to address urban issues in Japan, such as aging and depopulation, de-carbonisation, traffic jams, rush hours and security improvements.

Aizuwakamatsu City in western Fukushima Prefecture is promoting Smart City measures with private companies, including Accenture Japan Ltd, which established its innovation centre there shortly after the Great Tohoku Earthquake in 2011. The city is expanding and advancing public services through utilising ICT, such as operating a public portal site for regional information. The city is one of 52 designated areas for government demonstration projects as part of the “Smart Mobility Challenge”, and is the host of a MaaS in Smart City demonstration project.

In addition, a public-private consortium is promoting Smart City developments in an area of Otemachi, Marunouchi and Yurakucho, located between Tokyo station and the Imperial Palace. The project includes DX of the area management through gathering and utilising real-time data by providing several public services such as apps relating to mobility, emergency and health.

The Japanese government is formulating guidelines and other legislation to promote Smart City measures and the industrialisation of urban operating systems. An amendment to the National Strategy Special Regional Law came into force in September 2020 (the so-called Super City Act), to accelerate developments of the Smart City projects. Under this amendment, certain companies can gather regional data collated by government agencies and use a sandbox system for regulations in specific regions to conduct certain demonstrations, such as automatic driving. The investments and developments in this field are expected to progress steadily over the next few decades.

Electronic contracts

Due to the COVID-19 outbreak, demands to execute contracts in electronic form (an Electronic Contract) have increased. Another reason for this is that stamp duty is not required for agreements that are electronically delivered, which motivates transaction parties to use Electronic Contracts. Although the majority of real estate transactions in Japan still use written agreements, some companies engaged in real estate transactions – such as Nomura Real Estate Development Co., Ltd. – are introducing Electronic Contract services provided by DocuSign, CloudSign and other service providers.

In response to such increased demands, in 2020 the Japanese government announced that certain signatures signed electronically by an Electronic Contract platform provider under instructions from users through a strict certification process are considered to be electronic signatures signed by the users and presumed to be established authentically under the Electronic Signature Law (Act No 102 of 2000). In addition, a proposed Act on the Development of Related Laws for the Formation of a Digital Society was submitted to the Japanese National Diet in February 2021. This proposal includes several amendments of regulations so that seals and the delivery of certain written documents for real estate transactions may be omitted, such as certain documents explaining important matters under the Real Estate Brokerage Act (Act No 176 of 1952) and fixed term land/building lease agreements. These government announcements and amendments will further help real estate transactions in particular to be conducted electronically during the current COVID-19 situation.

Security token offerings

Amendments to the Financial Instruments and Exchange Act (Act No 25 of 1948 – FIEA) and the Payment Service Act (Act No 59 of 2008) were enforced on 1 May 2020 in response to the diverse range of financial instruments and investment schemes that are emerging as DX technology develops. These amendments established regulations for Security Token Offerings (STOs), including continuous disclosure obligations addressing information asymmetry between issuers and investors. The applicable regulations depend on whether or not the offered security token falls under “Electronically Recorded Transfer Claims", a new concept established under this amendment; if it does, it becomes more necessary for the issuers to consider the security token’s legal characteristics.

In addition to the FIEA, the Japan Security Token Offering Association as a self-regulatory organisation has published several self regulations for STOs, which must also be followed. Under the amendments, the regulations relating to STOs have become more clear and investors are able to receive more information regarding the security token, so real estate transactions using security tokens under the FIEA are likely to increase gradually.

Outbound Investments

Despite the COVID-19 pandemic, outbound investments have not been withdrawn. Over the past few years, Japanese investors have continuously expanded their outbound investments into foreign real estate markets, searching for opportunities to take advantage of good domestic economic strength mixed with relatively limited investment opportunities within Japan. A number of Japanese real estate developers have announced that they are or will be investing in real estate and real estate development businesses outside of Japan. This trend seems to have slowed down to some extent as a result of COVID-19’s negative impact on real estate market overseas, but most Japanese funds and investors are not yet withdrawing outbound investments.

Having said that, no new transactions where a J-REIT has acquired property overseas have yet been announced this year, although it has been confirmed that J-REITs are able to hold up to 100% of the equity of foreign real estate companies in certain foreign countries, including the USA, India, Indonesia, China, Vietnam and Malaysia. There have been three outbound investments by J-REITs to date:

  • AEON REIT Investment Corporation’s investment in a commercial property in Malaysia by acquiring 100% of the equity of a Malaysian SPC;
  • Invincible Investment Corporation’s investment in hotels in the Cayman Islands in 2018; and
  • the investment by a private J-REIT sponsored by Daiwa House in 100% of the equity of a Limited Liability Company that co-owns real estate in the USA.

REITs

In the Japanese capital markets, REITs have generally showed a strong and steady performance, although some hotel and commercial REITs seem to be struggling with the downturn in guest/consumer demand. The REIT index plummeted in March 2020 due to uncertainty caused by COVID-19, but has recovered quickly. The total value of real estate held by REITs including private REITs has reached approximately JPY24 trillion (on the basis of acquisition price), and the aggregate market capitalisation of listed REITs was about JPY14 trillion (approximately USD127.8 billion) at the end of 2020.

The growth of private REITs has played a certain role in the Japanese REIT market, with private REITs owning properties valued at about JPY4 trillion (on the basis of acquisition price) in December 2020. There are 36 REITs, ranging from comprehensive REITs (those diversifying their portfolio in multiple asset types) to sector-specific REITs, such as residential, hotel and logistic properties. Sponsors from various business fields have initiated private REITs. Financial institutions (including insurance companies and banks) and other industry are also engaging in, or interested in, the management of REITs.

One of the current key events in the REIT market is hostile takeovers of J-REITs. There were some M&A transactions between J-REITs before 2019, but all of them were friendly mergers under previous agreements between all relevant parties (including the sponsors). In addition, many of them were carried out between the J-REITs under the same sponsors or affiliated sponsors in an effort to increase their assets under management (AUM), expand the types of their assets, and/or streamline their business.

The first hostile REIT M&A transaction was completed in 2020. A minor shareholder called a shareholders’ meeting of a target REIT with the financial bureau’s permission, at which both the selection of a new officer on the minor shareholder side and the execution of a management agreement with a new sponsor and the termination of an existing management agreement were resolved. After the meeting, a merger was conducted between the REIT managed by the new sponsor and the target REIT.

The types of REIT M&A transactions are generally as follows:

  • mergers between two REITs (via a consolidation-type merger or an absorption-type merger);
  • the acquisition of an asset management company’s shares; and
  • the acquisition of all portfolio assets held by one REIT by the acquiring REIT.

As a general rule, a shareholders’ meeting will need to be held to approve a merger between two REITs.

It has generally been considered difficult to implement a hostile takeover of a J-REIT, mainly for the following reasons:

  • the requirements to qualify to avoid double taxation (ie, the deduction of dividends from a REIT’s taxable income) cannot be met if more than 50% of a J-REIT’s shares are purchased and owned by a specific investor group; and
  • acquiring the shares of a J-REIT is not sufficient to take control of a REIT – it is also necessary to take control of or replace the target REIT’s asset management company, since the asset management company has the authority to dispose of the real estate owned by the J-REIT.

Regarding the second reason in particular, a J-REIT’s asset manager is typically an unlisted subsidiary of its sponsor, so shares of such asset management company are usually not available to be acquired by a hostile acquirer. Furthermore, in terms of licensing, as a REIT’s asset management company can only be replaced by a company that is already licensed as another REIT’s asset management company, such replacement may give rise to a conflict of interest between two REITs.

To avoid these problems, the hostile takeover mentioned above replaced the target REIT’s asset management company with the asset management company of the acquiring REIT and then entered into a merger agreement between the two REITs, subject to the necessary approvals of the shareholders' meeting.

These types of transactions should be subject to merger approval by the shareholders of both REITs, so it will not be easy for other REITs to follow the same strategy. Even so, REIT asset management companies cannot overlook the possibility of such transactions, considering that a shareholder holding not less than 3% of issued shares for the preceding six-month period can request a shareholders’ meeting to be held regarding such transactions. Under these circumstances, it is becoming more important for REIT asset management companies to regularly provide a sufficient account to shareholders and to obtain their understanding of the advantages of having them manage REIT assets as well as their investment policies and investment records.

Furthermore, under the Act on Investment Trusts and Investment Corporations, a J-REIT may provide in its certificate of incorporation that shareholders who do not attend a shareholders’ meeting or exercise their voting rights in the shareholders’ meeting will be deemed to agree to the proposal(s) submitted to that meeting (the Deemed Votes in Favour Provision). Shareholders of J-REITs include many individual or corporate investors who are mainly hunting for high returns so are less concerned about attending shareholders’ meetings or exercising their voting rights. Therefore, most J-REIT asset management companies provide Deemed Votes in Favour Provisions in REIT certificates of incorporation in order to constitute a quorum and pass necessary resolutions at shareholders’ meetings. However, a Deemed Votes in Favour Provision can also apply to important proposals such as those for the replacement of management companies or the hostile takeover mentioned above, and consequently can make such transactions easier. Thus, Deemed Votes in Favour Provisions remain an issue for the future.

Renewable Energy

Even after the global COVID-19 pandemic exerted considerable pressure on economic activity in Japan, domestic and foreign investors have actively and consistently invested in Japanese renewable energy businesses. Such trends have continued since the Japanese Feed-in-Tariff regime (the FIT Regime) came into effect in July 2012. Under the FIT Regime, a relatively high fixed purchase price (eg, JPY40/kWh (plus consumption tax) for solar projects that meet certain requirements by the end of March 2013) for a fixed period of 20 years is determined at the outset of a project. After the FIT Regime began, the proportion of renewable energy in Japan’s power generation mix increased from approximately 9% to 18%.

A major amendment to the Japanese Renewable Energy Act (Act No 108 of 2011) was promulgated into law in June 2020 and will come into force in April 2022, and includes an expiration of certificate system where the certification of a renewable energy project will expire if a renewable energy generator fails to commence operation of its project by an applicable deadline, but this trend has still continued.

In addition to the ordinary renewable energy businesses (ie, solar, onshore wind and biomass), developments of offshore wind projects have greatly accelerated in recent years, in line with global trends. The major developers in this field are domestic energy businesses, including trading companies (shosha), major construction contractors and Japanese utilities.

The Offshore Renewable Energy Act (Act No 89 of 2018) came into force in April 2019, to promote the development of offshore wind projects in Japan. The Act governs offshore wind projects being developed in “open waters” – ie, projects that are not within port limits and are not subject to the Port and Harbour Act (Act No 218 of 1950). Under the Offshore Renewable Energy Act, the Japanese government designates specific zones for the development of offshore wind projects (Promotion Zones), which are sites available for tender and the award of occupancy permits with a maximum term of 30 years. In 2020, four tender processes commenced under the Offshore Renewable Energy Act for five Promotion Zones in Nagasaki Prefecture, Chiba Prefecture and Akita Prefecture. Additional Promotion Zones are expected to be designated within a few years, according to an announcement of the Japanese government indicating that ten sea areas have progressed to a certain level of preparation for starting projects.

Under its Green Growth Strategy towards 2050 Carbon Neutrality published in December 2020, the Japanese government plans to achieve around 50% to 60% of total power generation through renewable energy by 2050, with offshore wind power considered a high growth potential sector. In response to the legislation anticipated under this strategy, investments and developments in the renewable energy section will be continuously stimulated over the next few decades.

ESG

Environmental, social and governance (ESG) factors have gained attention in the real estate market as well as other investment sectors. The Government Pension Investment Fund, a major investor in Japan, signed the Principles for Responsible Investment advocated by the United Nations in 2015, and has been taking ESG factors into consideration when investing in assets, including real estate. This development seems to be influencing other investors.

To create a sustainable environment, it is generally understood that real estate, as a basic component of society, should follow global policy, such as sustainable development goals (SDGs), and contribute thereto. The real estate industry is thought to have significant potential to play an important role in meeting SDGs, especially with respect to the environment. There have been developments of buildings that achieve high environmental performance to reduce energy consumption. Buildings with environmental performance certificates appear to attract investments more than those without such certificates.

In line with the promotion of ESG, the number of Japanese participants in GRESB Real Estate Assessment has been increasing, with the participation rate of Listed J-REITs in the Assessment reported to have been approximately 90% (on the basis of market capitalisation) in 2019. GRESB Real Estate Assessment is the global ESG benchmark capturing information on ESG performance and sustainability best practices for real estate, and gives rating results. It appears that more and more investors have referred to GRESB Real Estate Assessment for their investment decisions, or are considering doing so.

The Japanese government is also delivering positive signals regarding ESG/SDGs and publishing its policies related to this field, such as SDGs Action Plan 2020, Financial Administration and SDGs, and the interim report for the promotion of ESG investment in real estate. The idea of a green lease is part of the government’s strategy to improve environmental performance in the real estate sector, which the Japanese government is also suggesting through its Green Lease Guideline. In a green lease, the owner and tenant share the costs for environmental improvements of the leased building.

Also, public money, together with private funds, has been flowing into investments to redevelop aged buildings and remodel them to have seismic or environmental capacity. The green bonds market is also growing and collecting funds to be spent on eco-friendly businesses.

ESG is currently early in its development in Japan, and it seems that ESG investment methods, disclosure models and ESG effects investment have not been established completely. Nevertheless, the global ESG trend will continue to grow in the Japanese real estate market, and attention needs to be paid to this development.

Nishimura & Asahi

Otemon Tower
1-1-2 Otemachi, Chiyoda-ku
Tokyo 100-8124
Japan

+81 3 6250 6200

+81 3 6250 7200

info@jurists.co.jp www.jurists.co.jp
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Law and Practice

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Mori Hamada & Matsumoto has 13 partners (nine Tokyo-based partners and four partners based in Singapore, Yangon and Bangkok) in the real estate team, plus three partners in the Japanese REITs (J-REITs) practice. Fifty other lawyers are also involved in real estate-related matters. The real estate practice extends from traditional acquisition and leasing transactions to complex fund structures involving a special purpose vehicle or a trust, or even investment structures for overseas properties. The team's work in this practice primarily includes private fund formation for domestic and overseas properties, J-REITs, real estate acquisition, development and disposition, and real estate financing. Recent highlights include advising GIC on the formation of a joint venture for hyperscale data centres, and acting for Daiwa House on establishing an open-ended fund to invest in logistic facilities.

Trends and Development

Authors



Nishimura & Asahi has substantial experience in a wide array of real estate securitisations in both domestic and cross-border transactions. The firm's real estate finance team has a proven track record in advising both lenders and borrowers in finance transactions throughout the real estate industry, offering expert assistance to clients in all stages of their transactions, from the term sheet and structuring stage through closing, tranching, syndication and securitisation, administration, servicing and, if required, restructuring. Since the early 2000s, the firm's lawyers have played a significant role in advising publicly traded REITs, private REITs, and real estate operating and finance companies in all stages of their life cycles, from REIT formation, roll-up transactions and initial public offerings to secondary debt and equity offerings, and REIT transactions. Nishimura & Asahi advises on real estate sales and purchases, investment, lease and management in Japan and abroad; as the growth in real estate funds and private equity investment in real estate increases, the firm has been advising all of the key fund-related specialties. Furthermore, the firm specialises in environmental law, providing risk analysis and settling disputes on soil pollution, asbestos and other environmental law issues that arise regarding real estate; capabilities extend to environmental law-related issues to be complied with by business entities and corporate social responsibility (CSR).

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